How owner-occupiers and property investors can make the most of an RBA rate cut

With the recent interest rate reduction in October by the Reserve Bank of Australia (RBA) and another one predicted to possibly occur on Melbourne Cup Day next week. I thought it would be a good time to have a look at just what a difference a 0.25-percentage-point drop in your interest rate really does and how to take advantage of it. (As long as the bank pass on the full rate reduction, but that’s a discussion for next month.)

The first thing that happens every time the rate drops is that every media outlet and even we often send out a chart of what happens with your repayments. And it’s true that on an average $350,000 mortgage a 0.25% difference will save you about $72.91 per month in interest.

For the clever investor or home owner, though, the impact can be far greater.

So how do you take advantage of the recent rate reductions?

For home owners looking to pay off their home

Maintain your current repayments

Now that sounds simple enough, but in reality this can be a little tricky because it can depend on your lender. You see some lenders like the idea of collecting 30 years’ worth of interest from you and will adjust your payments downward each time the interest rate drops. So you get a letter in the mail that says your new payment will be X, you read it and file in the circular filing cabinet. Then what ends up happening is that next month the automatic payment gets taken and you don’t realise and all of a sudden you have spent that extra $72.

If you want to really take advantage of the extra money what you may need to do is call your bank and change your repayment from the minimum amount to a set payment. It’s a simple call that could cut years of your home loan. Why not check out the Extra Repayment Calculator at chan-naylor.com.au/calculators and you will see that an extra repayment of $72 a month will cut a $350,000 mortgage by two years and eight months.

Put the extra fund towards paying off your credit cards

If you aren’t paying off your credit card on a monthly basis the rate reduction can be a great way to finally start bringing that credit card balance down. Again, this can be as simple as arranging with your bank to set up an automatic direct debit form the same account your mortgage payments where coming from so that you don’t notice the extra $72. And remember when rates are falling it can be a great time to negotiate to get your credit card interest rate down.

 

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It can be a great time to check out a new loan

Because the market is more competitive and lenders are trying to position themselves after a rate reduction and get you to commit, it can be a great time to shop around for a mortgage. Lenders tend to offer rate discounts and switching incentives to get you to sign on the dotted line, so negotiating can be easier. The savings made by reviewing your loans can be quite substantial, however as always, just be sure to weigh up the overall costs of refinancing (upfront, ongoing and exit fees) compared to the savings.

For property investors

In the last 12 months interest rates have dropped over 1.5 percentage points (according to the RBA website), that means we have had six rate drops of 25 basis points each in the last 12 months. Well, you're probably thinking that's pretty simple maths and rather obvious. But have you thought about the fact that these rate reductions have essentially reduced your interest cost by six times $72 a month? That means you now have almost $432 extra per month.

What if you put that $432 in cashflow per month back to work for you? With variable interest rates around 6% at the moment that’s an extra $86,400 you may be able to borrow. Probably not enough to get you into another property, but then these numbers are based on a single $350,000 loan.

What if you have a home loan and an investment property? You can see that the last 12 months could really be doing you some favours.  And with three-year and five-year fixed rates between 5.5% and 6% now is a great time to take advantage of a Free Lending Capacity Check to check your new borrowing capacity.

With your extra borrowing power it can be a great time to be looking for new property investments especially where property market prices have fallen. However when interest rates drop, eventually people start to notice the extra money in their pockets and eventually consumer confidence starts to return.

Now if anyone can tell me exactly when consumer confidence is going to return, as they say in the old movies I will buy them a steak dinner.

Albertus Waldron is finance strategist and partner at Chan & Naylor